Tax valuations can be subjective in nature, and it is therefore crucial that a tax valuation report is sufficiently robust to act as contemporaneous evidence should the value of the shares ever be challenged by HMRC.
This is particularly important where there is no mechanism for agreeing the valuation of the shares ‘upfront’ with HMRC, an area which we are seeing come under scrutiny more and more during due diligence exercises.
Throughout my career, I have seen numerous tax valuations, the focus of which has primarily been on the numbers, with limited narrative. Although they say, ‘the numbers don’t lie’, I have personally found that the corresponding narrative is often just as useful a tool to reach a defensible conclusion. It helps to ‘tell the story’, enabling our clients to better understand the tax valuation, whilst reducing the risk of a future challenge from HMRC.
As a result of the coronavirus pandemic, the subjectivity of tax valuations has become increasingly relevant. Consequently, a coherent narrative backing up the numbers has become significantly more important. A tax valuation must convince the reader that the conclusion reached is rational and considering the numbers alone simply will not achieve that.
Questions that have come up throughout the coronavirus pandemic pertain mainly to the reliability of the numbers. For example, how was the company performing before COVID-19? Were results during the pandemic considered to be exceptional? Should those results be ignored when calculating the current value of the company? Was performance experienced during the pandemic likely to continue or will performance go back to pre-pandemic levels? And so on and so forth.
The outcome has been that we have had to look beyond the numbers and focus more on not just the internal environment but to a large extent, the external environment. We have had detailed discussions with many business owners and finance directors to achieve this. Questions that we have asked include, how did the pandemic impact their performance and workforce? How did their competitors fare in comparison? How is the company and the market in which they are operating performing post-pandemic?
By having more detailed discussions, we have been able to ensure that the narrative of the valuation is airtight and fully supports our conclusions about the numbers, the general performance of the company, the market in which they operate and thus, what the future of the company looks like.
As a slight caveat, a tax valuation is based on established tax principles and case law, whereby the buyer and seller of the shares is considered to be ‘hypothetical’ and the market value is based on information available to a purchaser/seller of a shareholding of a particular size. However, as a result of COVID-19 and in determining whether a company’s results are exceptional or maintainable, there is a need to at least consider management accounts for the current year and potentially budgets and forecasts, if available. As opposed to relying on these numbers in the valuation, the information can be used to guide the narrative and bolster the valuation conclusion in terms of the expected performance of a company going forward.
Whilst the numbers don’t lie, the narrative is what is required to ensure the numbers are not misinterpreted and so we do not lead our clients, or HMRC, down the garden path.
In summary, it is not a question of numbers vs. narrative, it is more that the two go hand-in-hand when producing a robust and defensible tax valuation.
